Monday, December 31, 2012

First, I think there are some obvious implications for US policymakers: The
Federal Reserve has all but given fiscal policymakers the green light to
accelerate debt issuance to support stimulus efforts. Matthew
O'Brien at the Atlantic points out that while the Fed is willing to tolerate
inflation slightly as high as 2.5%, the Fed's forecast remains at 2.0% or below
through 2015. So the Fed is willing to tolerate higher inflation, but not
willing - or able - to generate higher inflation. The ball is thus passed to
fiscal policymakers to do the job. Fiscal policymakers, however, have fumbled
the ball. Badly. Even while the Treasury can borrow for 10 years at well below
2%, Washington is prepared to drop an austerity bomb on the economy. Austerity
looks to be a done deal; it is only the level of austerity that is at issue.

Second, a thread is making the rounds claiming that Japanese Prime Minister
Shinzo Abe is all bark, no bite. Joshua
Wojnilower argues that Abe is a closet austerian, thus ultimately the actual
stimulus enacted will be of the short-term, low-power variety. Noah
Smith is less diplomatic, pointing out that Abe's first time at the helm was
something of a disaster because Abe fundamentally has a narrow focus:

I of course don't mean to imply that Abe's cultural conservatism makes
him unlikely to experiment with monetary policy (unlike in America, in Japan
"hard money" is less of a conservative sacred cow). Instead, what I mean is
that Abe really just does not care very much at all about the economy. I
mean, of course he wants Japan to be strong, and of course he doesn't want
his party kicked out of power. But his overwhelming priority is erasing the
legacy of World War 2, with the economy a distant, distant second.

This is why Abe allows himself to be surrounded by corrupt and incompetent
people. He is entirely focused on his cultural conservative quest. The other
day Abe called Obama "Bush". He just deeply, truly, does not care about
stuff that does not involve boosting Japanese nationalism.

Smith has a theory:

So why is Abe making all this noise about revoking central bank
independence, setting hard inflation targets, etc.? I have a hypothesis: He
is talking down the yen.

There is a
long history of Japanese policymakers talking down the Yen; who could ever
forget former Finance Minister Eisuke Sakakibara, AKA Mr. Yen? That said, if Abe
wants a sustained depreciation, is is going to take something more than just talk.
After all, look at what has been accomplished over the past ten years:

If the goal of all the talk was a weak Yen, policymakers have failed miserably.
And If Abe can't follow through with a real policy change, talking alone will
continue to fail, and the recent decline in the Yen will prove ephemeral.

This leads me to my third thought, that the level of intervention required to
change the economic outcome is much, much higher than most anticipate. You
can't just dabble in monetization; you need to commit to it. Case in point:
Switzerland. Floyd Norris, the author of
the original NYT piece that prompted my initial post, seems to argue that
raising inflation is not all that hard:

“At this point, moving to a 2 percent target would not be such a giant
step,” said Kenneth Rogoff, a Harvard economist who has suggested inflation
targeting in the United States as well as in Japan. “They have to pursue it
vigorously until we have inflation expectations firmly higher. No one knows
how much they would have to do to accomplish that.”

The Bank of Japan has in the past been hesitant to really try to
establish that credibility...

To establish the credibility, the central bank would have to show a
readiness to create credit at a rapid rate. It would probably also need to
take steps to hold down the value of the yen, a move that would no doubt
cause concern in the United States.

It is, however, very doable, as Switzerland has shown. When the euro
zone debt crisis was at its worst, Switzerland became a safe haven for
European investors worried that the euro might blow up. That drove up the
value of the Swiss franc versus the euro and damaged Switzerland’s ability
to compete. The Swiss government responded by announcing that the euro
would not be allowed to fall below 1.2 Swiss francs. If necessary, the
government would simply sell francs to meet any demand.

That has been necessary, and the Swiss have accumulated a huge portfolio
of foreign currency. So, too, could the Japanese if they chose to announce
that the dollar would henceforth be worth at least 100 yen, a level not seen
since 2009.

Rogoff is correct; no one really knows what is necessary. I don't think that
100 yen is a meaningful target; aside from a couple of energy-price induced
spikes,
Japan has not had meaningful inflation since the early 1990's. The Yen has
fluctuated between 80 and 160 during that time. Shoot for 160 and it might be
interesting. And how does this relate to Switzerland? Although Norris holds it
out as an example, look at inflation in that economy:

And nominal GDP:

The Swiss National Bank appears to be struggling to stave off deflation and
stabilize the path of nominal GDP. So how exactly is this a lesson in
establishing inflation target credibility? Despite all the efforts of the Swiss
National Bank, their work still fall short.

Norris is certainly right on the political implications. I think the extent
of direct currency depreciation necessary to by itself meet a 2% inflation
target in Japan would be unacceptable to Japan's trade partners. Monetary
policy to support domestic demand - monetization of deficit spending - would be
much more tolerable, perhaps even welcome.

First, I think there are some obvious implications for US policymakers: The
Federal Reserve has all but given fiscal policymakers the green light to
accelerate debt issuance to support stimulus efforts. Matthew
O'Brien at the Atlantic points out that while the Fed is willing to tolerate
inflation slightly as high as 2.5%, the Fed's forecast remains at 2.0% or below
through 2015. So the Fed is willing to tolerate higher inflation, but not
willing - or able - to generate higher inflation. The ball is thus passed to
fiscal policymakers to do the job. Fiscal policymakers, however, have fumbled
the ball. Badly. Even while the Treasury can borrow for 10 years at well below
2%, Washington is prepared to drop an austerity bomb on the economy. Austerity
looks to be a done deal; it is only the level of austerity that is at issue.

Second, a thread is making the rounds claiming that Japanese Prime Minister
Shinzo Abe is all bark, no bite. Joshua
Wojnilower argues that Abe is a closet austerian, thus ultimately the actual
stimulus enacted will be of the short-term, low-power variety. Noah
Smith is less diplomatic, pointing out that Abe's first time at the helm was
something of a disaster because Abe fundamentally has a narrow focus:

I of course don't mean to imply that Abe's cultural conservatism makes
him unlikely to experiment with monetary policy (unlike in America, in Japan
"hard money" is less of a conservative sacred cow). Instead, what I mean is
that Abe really just does not care very much at all about the economy. I
mean, of course he wants Japan to be strong, and of course he doesn't want
his party kicked out of power. But his overwhelming priority is erasing the
legacy of World War 2, with the economy a distant, distant second.

This is why Abe allows himself to be surrounded by corrupt and incompetent
people. He is entirely focused on his cultural conservative quest. The other
day Abe called Obama "Bush". He just deeply, truly, does not care about
stuff that does not involve boosting Japanese nationalism.

Smith has a theory:

So why is Abe making all this noise about revoking central bank
independence, setting hard inflation targets, etc.? I have a hypothesis: He
is talking down the yen.

There is a
long history of Japanese policymakers talking down the Yen; who could ever
forget former Finance Minister Eisuke Sakakibara, AKA Mr. Yen? That said, if Abe
wants a sustained depreciation, is is going to take something more than just talk.
After all, look at what has been accomplished over the past ten years:

If the goal of all the talk was a weak Yen, policymakers have failed miserably.
And If Abe can't follow through with a real policy change, talking alone will
continue to fail, and the recent decline in the Yen will prove ephemeral.

This leads me to my third thought, that the level of intervention required to
change the economic outcome is much, much higher than most anticipate. You
can't just dabble in monetization; you need to commit to it. Case in point:
Switzerland. Floyd Norris, the author of
the original NYT piece that prompted my initial post, seems to argue that
raising inflation is not all that hard:

“At this point, moving to a 2 percent target would not be such a giant
step,” said Kenneth Rogoff, a Harvard economist who has suggested inflation
targeting in the United States as well as in Japan. “They have to pursue it
vigorously until we have inflation expectations firmly higher. No one knows
how much they would have to do to accomplish that.”

The Bank of Japan has in the past been hesitant to really try to
establish that credibility...

To establish the credibility, the central bank would have to show a
readiness to create credit at a rapid rate. It would probably also need to
take steps to hold down the value of the yen, a move that would no doubt
cause concern in the United States.

It is, however, very doable, as Switzerland has shown. When the euro
zone debt crisis was at its worst, Switzerland became a safe haven for
European investors worried that the euro might blow up. That drove up the
value of the Swiss franc versus the euro and damaged Switzerland’s ability
to compete. The Swiss government responded by announcing that the euro
would not be allowed to fall below 1.2 Swiss francs. If necessary, the
government would simply sell francs to meet any demand.

That has been necessary, and the Swiss have accumulated a huge portfolio
of foreign currency. So, too, could the Japanese if they chose to announce
that the dollar would henceforth be worth at least 100 yen, a level not seen
since 2009.

Rogoff is correct; no one really knows what is necessary. I don't think that
100 yen is a meaningful target; aside from a couple of energy-price induced
spikes,
Japan has not had meaningful inflation since the early 1990's. The Yen has
fluctuated between 80 and 160 during that time. Shoot for 160 and it might be
interesting. And how does this relate to Switzerland? Although Norris holds it
out as an example, look at inflation in that economy:

And nominal GDP:

The Swiss National Bank appears to be struggling to stave off deflation and
stabilize the path of nominal GDP. So how exactly is this a lesson in
establishing inflation target credibility? Despite all the efforts of the Swiss
National Bank, their work still fall short.

Norris is certainly right on the political implications. I think the extent
of direct currency depreciation necessary to by itself meet a 2% inflation
target in Japan would be unacceptable to Japan's trade partners. Monetary
policy to support domestic demand - monetization of deficit spending - would be
much more tolerable, perhaps even welcome.